It has been some time since I wrote a Stock Market Updates blog post and it feels good to share my opinions in this format again!
Today’s post deals with my “order of analysis” and it stems from a conversation I had with a colleague regarding how I approach the myriad of investing and trading decisions in the course of trying to narrow down the best possible vehicles where to deploy capital.
Stocks go up, go down or stay flat in price. If you are long (own the stock) and the stock goes up, you are going to make a profit. If you are long and the stock goes down in price, you are going to incur a loss. If what you own stays stagnant in price you will lose the opportunity cost of allocating your capital elsewhere but in real dollars and cents, beyond the transaction costs, you will not have incurred a gain or a loss. Simple right?
Well it is! What is not simple is this:
How do I know what and when to buy a stock and when to sell it?
First let’s consider some well know facts. Stocks in the long run have about a 70% to 75% chance of being higher or flat on a daily basis. That is a very powerful statement of fact and the primary reason why most individual investors should stay far away from shorting stocks. Shorting stocks is when you borrow shares on margin in hope of closing the trade at a lower price point. Or simply stated, when your bet is that the stock will go down.
So if we agree 75% of the time stocks go up or stay flat, then it follows that our job as investors and traders is to choose those stocks that have a better probability of going up! Of course easier said than done… and in there lies the topic of this post.
Quantitative, Fundamental, Technical…
As a market participant I always chuckle at those debates of who is right or wrong or which discipline is “best”, Quantitative Analysis, Fundamental Analysis or Technical Analysis. If you click on the links, you will get a more in-depth description of each but for the purpose of this article, lets look at it as such:
Quantitative analysis, tries to arrive at an answer by evaluating questions of “How much”.
Real buy and sell figures at various price points over time. Some folks out there have begun calling this “evidence based” investing. I am good with quantitative analysis. No need to rename something that has been around for many years just for the sake of launching a new marketing campaign.
This is a factor that I consider paramount. I want to buy a stock that is in the beginning of an accumulation phase. No matter how good a stock may seem from a fundamental or technical basis, if no one is buying the stock, it will languish and remain flat. Do we want our limited allocation of money to be deployed to a stock that will more than likely remain flat? The answer is definitely no. As individual investors we have a limited amount of cash to deploy to our investment positions and a flat stock does us no good.
Many so-called “value” stocks fall under this criteria. Often a stock looks great from a fundamental point of view but for some reason or another it goes unnoticed by the market. If no one is buying it does it matter if it’s a great fundamental story? What is the point of holding a stock for years with the hope that the market will eventually recognize what you have?
Once we find stocks that pass our quantitative analysis and screens, the next thing we look at is the fundamental merits of these stocks. In other words we look to answer the following:
Do I agree with the fundamental reason behind the quantifiable buying of the stock?
Fundamental analysis refers to a company’s business metrics. Is the company earning a profit? is it over valued versus its peers? does it have a price to earnings ratio above the broad market benchmark and so forth. I want to own stocks that are beginning to move higher whose fundamental story makes sense to me. Does the company make a product or offer a service I support and believe in?
Some traders will say this doesn’t matter. “who cares if it’s a “good” company or stock…it’s moving so just buy it” Well this may work in the near term but a stock will eventually trade-off of reality. A hyped up stock with poor fundamentals may fly high quickly but will fall just as quickly. I for one prefer to own stocks I believe in and understand from a fundamental point of view.
Technical indicators and pattern recognition
Lastly and least important of all in my opinion is technical analysis. Technical analysis is esoteric in the sense that it can be referred to as art just as easily as it could science. Patterns and the action of traders, (buy or sell) when these patterns are recognized in charts can and do move markets.
Over the years, many quantitative indicators have been lumped into the broad category of “technical analysis” incorrectly. At its pure sense, technical analysis is the study of price action. Technical analysts use price charts to try to determine when both short-term and longer term price inflections are about to occur. In the near term, an understanding of technical analysis can help better an entry or exit point once you are ready to place your trade.
So there you are! Quantitative + Fundamental + Technical analysis. All three have their place, some more so than others. Keep your analysis to this order and watch your profits grow !